When investing, should you focus on income or total return? I like the idea of living off dividend and interest income, but I also think it is easy for people to reach too far for yield and hurt their overall returns. But what is too far? That’s the hard part. Certainly there are many bad investments lurking out there for desperate retirees looking for maximum income. If possible, I’d like to invest for total return and then live off the income.

A quick and dirty way to see how much income (dividends and interest) your portfolio is generating is to take the “TTM Yield” or “12 Mo. Yield” from Morningstar quote pages. Trailing 12 Month Yield is the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. SEC yield is another alternative, but I like TTM because it is based on actual distributions (SEC vs. TTM yield article).

Below is a close approximation of my most recent portfolio update. I have changed my asset allocation slightly to 60% stocks and 40% bonds because I believe that will be my permanent allocation upon early retirement.

The total weighted 12-month yield was 2.41%, as opposed to 2.49% and 2.31% the previous two quarters. This means that if I had a $1,000,000 portfolio balance today, it would have generated $24,100 in interest and dividends over the last 12 months. Now, 2.41% is significantly lower than the 4% withdrawal rate often recommended for 65-year-old retirees with 30-year spending horizons, and is also lower than the 3% withdrawal that I prefer as a rough benchmark for early retirement. But in theory the total return will be much greater due to share appreciation.

As noted previously, a simple benchmark for this portfolio is Vanguard LifeStrategy Growth Fund (VASGX) which is an all-in-one fund that is also 60% stocks and 40% bonds. That fund has a trailing 12-month yield of 2.09%. Keep in mind that the muni bond interest in my portfolio is exempt from federal income taxes.

So how am I doing? Using my 3% benchmark, the combination of ongoing savings and recent market gains have us at 91% of the way to matching our annual household spending target. Using the 2.41% number, I am only 73% of the way there. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems like a very conservative lower bound.

Here’s a final update on my investment portfolio holdings for 2014. This includes tax-deferred accounts like 401(k)s and taxable brokerage holdings, but excludes things like physical property and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover all of our household expenses.

Target Asset Allocation

I try to pick asset classes that will provide long-term returns above inflation, distribute income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I am not confident in them enough to know that I will hold them through an extended period of underperformance (i.e. don’t buy what you don’t understand).

Our current ratio is roughly 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With a self-directed portfolio of low-cost funds and low turnover, we minimize management fees, commissions, and taxes.

There was very little activity during the last quarter of 2014. I’ll need to do some rebalancing in the beginning of 2015. I did change my asset allocation tree above to reflect that my bond holdings have a weighted duration of close to 4 years now. It used to say “shorter-term” but really now it is more “intermediate-term”. I’ve been putting my new bond money into VWIUX, which holds intermediate-term high-quality municipal bonds. I haven’t sold any of my limited-term holdings. Overall, it’s a little longer in maturity and a little higher yield, but nothing drastic. I don’t really listen to future rate predictions; they’ve been wrong more than they’ve been right.

A simple benchmark for my portfolio is 50% Vanguard LifeStrategy Growth Fund (VASGX) and Vanguard LifeStrategy Moderate Growth Fund (VSMGX), one is 60/40 and one is 80/20 so it also works out to 70% stocks and 30% bonds. That would have returned about 7.1% for 2014. One reason for my portfolio’s relative underperformance to this benchmark is my inclusions of TIPS bonds which returned 3.5% whereas the Vanguard Total International Bond Index Fund (BND) returned 6% for the year. I’m still happy to hold TIPS. If I had more tax-advantaged space and/or a lower tax rate I’d hold BND instead of muni bonds but I’m still happy with my muni funds as well.

In a separate post, I will update the amount of income that I am deriving from this portfolio along with how that compares to my expenses.

When investing, should you focus on income, or total return? I like the idea of living off dividend and interest income, but I also think it is easy for people to reach too far for yield and hurt their overall returns. But what is too far? That’s the hard part. Certainly there are many bad investments lurking out there for desperate retirees looking for maximum income. If possible, I’d like to invest for total return and then live off the income.

A quick and dirty way to see how much income (dividends and interest) your portfolio is generating is to take the “TTM Yield” or “12 Mo. Yield” from Morningstar quote pages. Trailing 12 Month Yield is the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. SEC yield is another alternative, but I like TTM because it is based on actual distributions (SEC vs. TTM yield article).

Below is a close approximation of my most recent portfolio update. I have changed my asset allocation slightly to 60% stocks and 40% bonds because I believe that will be my permanent allocation upon early retirement.

Asset Class / Fund

% of Portfolio

Trailing 12-Month Yield (10/18/14)

Yield Contribution

US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)

24%

1.78%

0.43%

US Small Value
WisdomTree SmallCap Dividend ETF (DES)

3%

2.81%

0.08%

International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)

The total weighted yield was 2.31%, as opposed to 2.49% calculated last quarter. This means that if I had a $1,000,000 portfolio balance today, it would have generated $23,100 in interest and dividends over the last 12 months. Now, 2.31% is significantly lower than the 4% withdrawal rate often recommended for 65-year-old retirees with 30-year spending horizons, and is also lower than the 3% withdrawal that I prefer as a rough benchmark for early retirement. Hurray for zero interest rates!

So how am I doing? Using my 3% benchmark, the combination of ongoing savings and recent market gains have us at 90% of the way to matching our annual household spending target. Using the 2.31% number, I am only 69% of the way there. That’s a big difference, and something I’ll have to reconcile. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems extremely cautious.

Here’s an update on my investment portfolio holdings for Q3 2014. This includes tax-deferred accounts like 401(k)s and taxable brokerage holdings, but excludes things like physical property and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover all of our household expenses.

Target Asset Allocation

I try to pick asset classes that will provide long-term returns above inflation, regular income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I am not confident in them enough to know that I will hold them through an extended period of underperformance (don’t buy what you don’t understand).

Our current ratio is about 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With a self-directed portfolio of low-cost index funds and low turnover, we minimize management fees, commissions, and taxes.

Last quarter, I had sold my PIMCO Total Return fund holdings. Well, that was lucky on my part with all the recent Bill Gross drama. I decided to sell my stable value fund holdings too as I needed rebalance into more TIPS bonds and I was now able to buy TIPS inside my employee retirement plan using the Schwab PCRA brokerage window. All of our tax-deferred space is now taken up with TIPS and REITs, so the rest of my bonds are tax-exempt munis and savings bonds.

Otherwise, not much new, I rebalanced with new money and reinvested dividends. By this, I mean I don’t automatically reinvest dividends into the same mutual fund or ETF that generated them. Instead, they accumulate for bit and then I reinvest them in whatever asset class has been lagging recently. This also makes fewer tax lots for my taxable accounts.

That’s it for portfolio holdings. In a separate update post, I will update the amount of income that I am deriving from this portfolio.

I want to get back to doing quarterly updates to our investment portfolio, which includes both tax-deferred accounts like 401(k)s and taxable brokerage holdings. Other stuff like cash reserves (emergency fund) are excluded. The purpose of this portfolio is to create enough income on its own to cover all daily expenses well before we hit the standard retirement age.

Target Asset Allocation

I try to pick asset classes that will provide long-term returns above inflation, regular income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I am not confident in them enough to know that I will hold them through an extended period of underperformance (and if you don’t do that, there’s no point).

Our current ratio is about 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With low expense ratios and low turnover, we minimize our costs in terms of paying fees, commissions, and taxes.

Changes
I joined the exodus out of PIMCO Total Return fund earlier this year after their recent management shake-up. It actually coincided with my 401(k) allowing a self-directed brokerage “window” with Charles Schwab that allows me to buy Vanguard mutual funds, albeit with a $50 transaction fee. But my 401k assets are finally large enough that the $50 is worth the ongoing lower expense ratios. I’m buying more REITs and TIPS in order to take advantage of this newly-flexible tax-deferred space. I’m still holding onto my stable value fund, but I may sell that position as well in the future.

I think I mentioned this elsewhere, but I am now accounting for my Series I US Savings Bonds as part the TIPS asset class inside my retirement portfolio. Before, they were considered part of my emergency fund. They offer great tax-deferral benefits as I don’t have to pay taxes until they are redeemed. I don’t plan on selling any of them for a long time, at least until my tax rate is much lower in early retirement.

Here’s a 2013 year-end update of our retirement portfolio, which includes employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. The purpose of this portfolio is to eventually create enough income on its own to cover all daily expenses.

Target Asset Allocation

This has been mostly the same for over 6 years, although I did make some slight tweaks in my last June 2013 update.

I try to pick asset classes that are likely to provide a long-term return above inflation, as well as offer some historical tendencies to be less correlated to each other. I don’t hold commodities futures or gold because theoretically their prices should only match inflation. In addition, I am not confident in them enough to know that I will hold them through an extended period of underperformance (and if you don’t do that, there’s no point). 2013 turned out to be a tough year for both gold and commodities funds.

Our current ratio is about 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With low expense ratios and low turnover, we minimize our costs in terms of paying fees, commissions, and taxes.

The holdings haven’t changed through the latter half of this year, just some additional purchases of existing funds.

In terms of performance, in general stocks had a great year while bonds pretty much went nowhere or slightly down. I don’t expect everything to go up every year, not to mention my portfolio is bigger than I could have expected just a few years ago, so I can’t complain. Here are some 2013 YTD total returns for selected representative funds as of 12/27/13:

Stocks
Total US VTI +33%
Total International VXUS +14%
US Small Cap Value DES +37%
Emerging Market Small Cap Value DGS -5%
US REITs VNQ +3%

Here’s a mid-2013 update of our retirement portfolio, including employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. The purpose of this portfolio is to eventually create income and enable financial freedom.

Target Asset Allocation

Since my last update, I made a minor change to our target asset allocation by removing Emerging Markets as a separate added weighting as it now includes some huge companies and comprises nearly 20% of the Total World ex-US (Total International) asset class.

Thinking about goals and the future some more, I have this picture in my head of our dream future in 5-10 years:

- I work at a job I enjoy for only 20 hours a week
- My wife also works at a job she enjoys for only 20 hours a week
- We both share responsibility for taking care of our kids with minimal, if any, need for daycare.
- Our combined incomes still make it possible for us to reach our financial goals. However, we’re not really interested in being filthy rich.

We are gonna make this happen. Check back with me on 12/3/2015

Done.

We both really wanted this, even though we are more tired now than when we were both working full-time. (Even though we sleep at 9pm now instead of 1am.) Although I write about money daily (at times it may seem like an obsession)… it certainly didn’t feel like 8 years had gone by since I made this goal.

I recently bought a new print that will be in my daughter’s room eventually, but for now hangs in my home office. It says Don’t Forget To Be Awesome. I think we all have own personal definition of “awesome” – whether it’s starting your own business to being active in your community to simply being a good parent (even though that is anything but simple). Now, we are still far from reaching our “awesome”. But I think the phrasing is perfect; it’s so easy to forget to pursue our unique dreams in today’s hectic, noisy world.

Here’s a belated 2012 year-end update of our investment portfolio, including employer 401(k) plans, self-employed retirement plans, Traditional and Roth IRAs, and taxable brokerage holdings. Cash reserves (emergency fund), college savings accounts, experimental portfolios, and day-to-day cash balances are excluded. This is the portfolio that we are depending on to create income and thus financial freedom.

The free Personal Financial Planning course on Coursera has begun (there’s still time to join), and the first week’s topic is “Where are you? Where are you going”. One of the activities is calculating your personal net worth.

It may seem like a small thing, summing up your assets and subtracting your liabilities, but I am a living example that it does make a difference. I posted my first public net worth on December 9th, 2004:

(I had a lot of money tied up in no fee 0% balance transfers at the time, with the money safely earning 3-5% interest in bank accounts.)

Now, I no longer share our raw numbers on the internet down to the dollar, but I still track my net worth privately and update my progress towards financial freedom regularly. I definitely think it made a difference, seeing the benefits of a pay raise or debt payoff. A little over 8 years later, our net worth is many times larger and we plan on paying off our mortgage completely this year. Knowing how you stand won’t solve all your problems, but it may give you a reality check especially if you were like me and exiting college well with a 5-figure negative net worth.

As I’m sure someone wise/rich/famous has said – “If you don’t know where you are, then how do you know how to get where you’re going?”

Or the other classic – “If you don’t know where you’re going, any road’ll take you there”

This updated post explains my ratio-based method of tracking our financial progress towards early retirement (as shown by the status indicator on the top right of every blog page).

Cash Reserves / Emergency Fund

Our goal is to always have a full year of expenses in cash equivalents as our “emergency fund”. (This is not the same as a year of income. Our expenses are much lower than our income.) This is a cushion for a variety of potential events including job loss, health concerns, or other unplanned costs. It also allows us to take a more long-term view with our investment portfolio since we know we won’t have to touch it.

Since our emergency fund is relatively large, I try to maximize the yield. If we stuck it all in a money market fund, the yield would be barely above zero. With a bit of work, our cash earns a blended rate of over 2% annually without taking on extra risk. We use the same accounts to make money from no fee 0% APR balance transfer offers, but currently don’t play that “game”. Here are recent updates on where we keep our cash:

Home Equity

I don’t think everyone should buy a house (or more accurately, take out a huge loan on a house), as it historically doesn’t necessarily work out to be a very good investment over short or even long periods. However, if you are geographically stable, I do think buying and eventually owning a house free and clear can be a solid component of an early retirement plan. My current forecast is to have our house paid off in 10-15 5-10 years. Housing is very expensive where I live, so once that mortgage payment is gone, the actual income my investments will have to produce will drop drastically.

There are many ways to define home equity, and I am sticking to a simple method of calculating home equity by taking 100% minus (outstanding mortgage balance / original home purchase price). As of 2011, our home price has rebounded to over the original purchase price according to a refinance appraisal and comparable sales. Overall, I’d rather enjoy having continuous progress without worrying about my home’s exact market value. Here are some previous mortgage updates:

Investment Portfolio

The goal of my investment portfolio is allow withdrawals to support our needed expenses in “retirement”. Again, income and expenses are not the same thing. After mortgage payoff, I expect our required expenses to be less than 25% of our current income. I like to assume a simple 3% safe withdrawal rate, which means for every $100,000 saved, I can generate $3,000 a year of inflation-adjusted income for the rest of our lives. I used to assume 4%, but since our target “retirement” age is in our 40s and not 60s, I feel that 3% is better. Even 3% is not guaranteed, but again it does provide a quick estimate of progress. Here are recent portfolio updates:

My initial goal was to try and keep the home equity and expense replacement ratio about the same so that both will reach 100% at the same time, but we’ll see. I am still (very slowly) researching shifting to a more income-oriented portfolio that yields about 3% and has a principal value that can grow with inflation.

The actual implementation of my plan will probably require more flexibility. At some point, I plan on using some of my money and invest in an immediate annuity for some income stability. I’ll also need to vary my exact withdrawal rates a bit with market conditions. Once I reach age 70 or so, Social Security will kick in something. I don’t think Social Security will disappear although I do expect means-testing, but who knows these days.

When dealing with other people, it’s always easier when you know what makes them tick. What motivates them? This led to some introspection. What did I really want out of life? I realized that I was probably much different than others. The following characteristics aren’t mutually-exclusive, there is no wrong or right really, as everyone may have a little of each but you may realize one is prominent.

Don’t take the Lego characters too seriously either, eh? I just went to a Lego-themed birthday party and watched Star Wars again.

Prestige

“I seek the admiration and respect of others.”

Power

“I like being the boss and giving orders.”

Duty / Honor

“I find a higher calling in serving my religion/country/world.”

Passion

“I love my job.”

Family

“I want be a good wife/husband/mother/father.”

Personal Freedom

“I don’t take orders from anyone.”

Path of Least Resistance

“I don’t question the status quo and like to follow others.”

I would say that my top preferences from highest to lowest would be personal freedom, family, and duty. I’m still working on starting a family and how to best help higher causes. Low on my list is power and prestige. I don’t enjoy managing others (having people below me in the ranks) or being told what to do (having people above me). I feel this hurts me in the areas of leadership and probably makes me a bad employee. This make me think I should just work for myself. How about you?

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